The REIT Business Model

Which way will property companies go?

Stephen Hester, Chief Executive

We are real estate

investors and create
value by actively
managing, financing
and developing prime
commercial property
to provide the
environment in which
modern business can
thrive.
23 November 2006

The REIT Business Model

Introduction
What are UK REITs (& what are they not)
Effects of the REIT regime
Income Will strategies change
Investor Base Impacts
Lessons from Abroad
Making Money Let different models flourish

23 November 2006

The REIT Business Model

What are UK REITs (& what are they not)

UK Quoted Property Companies
Tax free (income & capital), post entry charge
Light touch regulation on gearing & business focus
Minimum dividend payout

Full stop
The UK REIT regime does not

Discriminate between types of real estate

Place limits on development
Substantially change the way investors will make money
Remove responsibility from management and investors to design and pursue real estate
based value creation

23 November 2006

The REIT Business Model

Direct Effects of the REIT Regime

Earnings & Dividend yield (property majors1) increases c.0.6% respectively
Yield %

8
6

Tax saved less financing cost

of REIT entry charge

4
2
0

EPS

DPS
Majors1

EPS

DPS

FTSE 1002

Total Return & its composition (property majors1)

2007E3
As Is %

REITs %

Change %

10.1

10.7

% from Dividends

18

22

22

% from NAV

82

78

(5)

Total Return

Few direct regulatory effects expected as the regulatory constraints do not in

practice restrict existing business models
23 November 2006

1 Average of UK majors (British Land, Land Securities, Hammerson, Liberty and Slough) estimated earnings and
dividend yield pro forma for REITs (based on taxed saved less financing cost of entry charge) most
companies have not yet confirmed their REIT dividend policy
2 Actual earnings and dividend yield of FTSE 100 per Bloomberg, 13 November 2006
3 Based on Merrill Lynch forecasts

The REIT Business Model

Second Order Effects of REITs

Gearing & Loss of Tax Shield on Interest
Cost of Equity: 8-9%1

Cost of Debt: 5-5.5%1 (up from c.4% as tax shield lost)

PMA predicted asset returns: 7%2 (less average 1.3%3 expenses)

Still efficient to use leverage and indeed necessary to achieve adequate

equity market returns but closer to cross-over point so business risk
more important to assess
Asset Turnover
Some asset sales will be more tax efficient so turnover encouraged, offset by stamp duty
effect to an extent
Resultant impact may be individually important, but cumulatively unlikely to exceed, say,
0.25% improvement in overall IRRs
23 November 2006

1 UBS
2 Property Market Analysis (PMA), September 2006 forecast total property returns pa over next 5 years
3 Average of UK majors (British Land, Land Securities, Hammerson, Liberty and Slough)

The REIT Business Model

Income Will Strategies Change?

REITs lose tax shield on expenses, but also lose tax on capital gains so
incentives to move from a total return to an income strategy are muted

Will activities that depress current income be reduced e.g. development, asset
management initiatives, lease extensions, holding lower yielding prime assets, use
of gearing
Yes if these relied on the tax shield for justification, but virtually none do..
In a minority of specialised cases, very high yield, secondary property strategies have an
investor niche
In the majority of cases, total return is enhanced by these activities and total return will
remain the yardstick

However, irrespective of REITs, in a lower growth environment income may get

more focus, albeit seldom at the expense of total return
23 November 2006

The REIT Business Model

Investor Base Impacts Will REITs Change the Investor Base?

Retail Investors1

International Investors British Land register

40

15%

UK
US

25%

Australia

21%

Japan

21%
21%

38%
40%

25%

50%

35%

5%

Singapore

36.0

35
30

28.4

2004

2005

24.6

25
20

27.6

16.8

15
10

25%

% of Share Register

11%

10
20
30
40
Retail % of share register (by value)

50

Broader Equities
REITs
REITs (inc. investment via REIT securities funds)

5
0
2002

Europe

2003

North America

2006

Rest of World

Real Estate investment has joined the globalisation trend and this will
continue, REITs or not.
There is little evidence that a new wave of retail investment is in prospect
however though specialist REIT funds may take share in institutional sales.
23 November 2006

1 UBS, November 2006

The REIT Business Model

Industry Power of Quoted Property Companies

An Opportunity?
UK Commercial Property Ownership1
Estates &
Charities 5%

Other
UK Private Investors
Investors 3% 5%
UK Institutions
28%

Limited Partnerships
7%
Unlisted & Pooled Funds
8%

Overseas Investors
15%

UK Unlisted Property
Companies 15%

UK Listed Property
Companies 14%

A more competitive quoted sector can influence industry trends and behaviour,
but the scale of influence is tempered by equivalent tax status elsewhere and
the quoted sectors limited market share
23 November 2006

1 investment Property Forum (IPF), July 2005

The REIT Business Model

Lessons from Abroad How Might Valuations Change?

Logical change will be NPV of tax benefits (1st & 2nd order effects)
Could there be a publicity effect, leading to further reassessment of valuation?
What do international comparisons tells us?
Average NAV Premium1

Cash Yields2 vs Income Differential1

Cash Yield2 2.6%

60

32

29

10

4.6

4.6

5.2%

4.5%

1.4

5.6

3.5
1.4

3.7

3
%

% 30
20

5.9%
0.3

41

40

5.1%

50

50

4.5%

3.1

2
1.7

1
0

0
UK

US

Europe

Australia

J REITs

Singapore

-1

-0.1
-2.0

-2
-3
UK

US

10 year bond

23 November 2006

Europe

Australia

J REITs

Singapore

REIT Cash Yields less government bond yield

1 UBS, November 2006

2 Cash Flow adjusted for real capex

The REIT Business Model

Lessons from Abroad

REIT Business Focus:
Global Top 20 REITs1
Industrial
5%
Diversfied
35%

Office
15%

Size vs Performance:
Total Shareholder Return vs
Market Cap - US1
60

Single
Country
30%

R2 = 0.1584

50
40
3-yr CAGR (%)

Residential
5%

Geographic Focus:
Global Top 20 REITs1

30
20
10
0
(10)

CrossBorder
70%

Retail
40%

(20)
(30)
-

5,000

10,000 15,000 20,000 25,000

Market cap (US$m)

There is no right business model. The market supports a range of size and
business models successfully
23 November 2006

1 UBS, November 2006

The REIT Business Model

Lessons from Abroad The Worlds Top 20 REITs

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Company

Mkt Cap

Domicile

Westfield
Simon Property
Vornado Realty
Equity Office
Equity Residential
Boston Properties
General Growth Properties
Unibail
Rodamco Europe
Kimco Realty Corp
AvalonBay Communities
Gecina
Macquarie Goodman
Stockland
GPT
Klepierre
Developers Diversified Realty
Nippon Building Fund Mgt
Lend Lease Corp
Centro Properties Group

$24.8bn
$21.0bn
$16.6bn
$15.0bn
$14.8bn
$12.4bn
$11.4bn
$10.5bn
$10.4bn
$10.3bn
$9.3bn
$8.9bn
$8.4bn
$8.0bn
$7.6bn
$7.2bn
$6.6bn
$5.5bn
$5.3bn
$5.0bn

Australia
US
US
US
US
US
US
France
Netherlands
US
US
France
Australia
Australia
Australia
France
US
Japan
Australia
Australia

Business Focus
121 regional shopping centres comprising 110m sq ft in 4 countries
More than 200m sq ft of retail in 39 US states and interests in 52 countries
58m sq ft of office and retail located in Washington DC, New York & California
590 office buildings totalling 105m sq ft in approximately 16 US states
Owns/develops multi-family properties 160,000 apartments in 27 US states
Owns/develops 121 office properties in Boston, New York, Washington DC
Owns/manages shopping malls across the US, Brazil, and Europe
8.6bn invested in offices, shopping centres & exhibition halls in France
32m sq ft of retail, office & industrial space in Europe
1,118 shopping centres (144m sq ft) in 45 US states, Canada & Mexico
Owns/develops apartment communities in 10 US states
Owns & manages 28m sq ft of office and residential accommodation in France
Owns/develops 98m sq ft of industrial & business space in Europe & Asia
Owns/develops industrial & office parks and retail in Australia & New Zealand
More than 40 retail, office and industrial/business properties across Australia
7.9bn of shopping centre and office assets in 10 European countries
Owns/manages 500 retail assets (118m sq ft) in 44 US states & Brazil
Mainly invests in offices located in Tokyo and other major Japanese cities
Owns/manages retail & residential globally and construction management
Owns/manages shopping centres in Australia, 18 US states & New Zealand

23 November 2006

10

The REIT Business Model

Making Money Let Different Models Flourish

UK REITs are an important reform and will boost the valuation and competitive
position of the UK Quoted Sector
But, freed of the tax distortion, companies have an unchanged goal to make
money for shareholders out of real estate
There is no singular model that works either in real estate or other industries
Companies will pursue diverse strategies in diverse structures based on their own
assets and competencies
Capital markets will ultimately reward success, not fashion

23 November 2006

11

Disclaimer

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23 November 2006